To The Moon

$Microsoft(MSFT)$

Microsoft Corporation is currently trading near its 52-week low at $392 per share, following a notable sell-off over the past month, with the stock down approximately 9%. Interestingly, the CNN Fear & Greed Index, which gauges market sentiment, is in the "Extreme Fear" zone. Additionally, a year-to-date heat map of the S&P 500 shows many major tech stocks in the red for 2025, with the overall index also down.

So, is this a prime buying opportunity for Microsoft? There’s a lot to unpack, so let’s dive in.

Quantum Computing Breakthrough

One major development is Microsoft’s recent breakthrough in quantum computing, a milestone that hasn’t received much media coverage. This is particularly interesting given that tech leaders like Nvidia’s CEO estimate quantum computing is still 15 years away, Meta’s Mark Zuckerberg suggests it's over a decade out, and Google’s CEO projects a 5–10 year timeline. However, Microsoft has introduced a new chip that could bring quantum computing within reach much sooner, potentially reshaping the market's expectations. Yet, despite this breakthrough, Microsoft’s stock has declined, raising questions about investor sentiment.

Recent Earnings Report

Microsoft’s latest quarterly earnings, released a month ago, provide more insight. The company operates through three main business segments:

• Productivity & Business Processes: Grew 14%

• Intelligent Cloud: Grew 19%

• More Personal Computing: Flat at 0% growth

One key highlight from the report is the $9.7 billion returned to shareholders, with $6.2 billion in dividends and $3.5 billion in share repurchases. However, a notable point of concern is Microsoft’s free cash flow, which declined 29% year-over-year to $6.5 billion. While this might appear alarming, it primarily reflects increased capital expenditures to support cloud and AI expansion.

AI Investment Concerns & Deep Seek Competition

Over the past month, uncertainty has emerged regarding Microsoft’s AI infrastructure spending. Reports suggest Microsoft has canceled some data center leases, adding to investor skepticism about the billions U.S. tech firms are allocating to AI. Additionally, the Chinese startup Deep Seek has showcased AI technology that could be significantly more cost-efficient than current Western approaches. While the full impact of this remains uncertain, Microsoft may address these concerns in its next earnings report.

Dividend & Long-Term Growth Potential

From a dividend perspective, Microsoft’s current yield of 0.81% might seem modest, but its long-term dividend growth potential is strong. The company has a history of consistent increases, with a 10-year dividend CAGR of nearly 9.5%.

One impressive aspect of Microsoft's financials is its free cash flow payout ratio over time. As free cash flow has grown at a rapid pace, the percentage of it needed to cover dividend payments has declined. This means Microsoft has even more capacity to increase dividend payouts in the future if it chooses to do so.

Competitive Advantage & Key Metrics

Looking at Microsoft’s fundamentals, revenue per share, earnings per share, and free cash flow per share have all seen exceptional growth over the past decade. Two key indicators of a company’s competitive advantage are Return on Invested Capital (ROIC) and Gross Profit Ratio.

• Gross Profit Ratio: A strong company should maintain or gradually increase this metric. Microsoft's 10-year average is around 67%, but last year it was closer to 70%, showing improving profitability.

• Return on Invested Capital (ROIC): This measures how efficiently a company generates profit from its investments. A strong company typically has an ROIC above 10%, while high-quality firms hit 20% or more. Microsoft has consistently exceeded 20% since 2021, reinforcing its competitive edge.

Another key factor is Microsoft’s broad range of business segments, as shown in its earnings report. For instance:

• Microsoft Cloud revenue grew 21% year-over-year

• Microsoft 365 commercial products & cloud services revenue increased 15%

• Several other business lines saw growth rates exceeding 30%

This diversification makes Microsoft almost like a tech-focused ETF, with multiple high-growth business units operating under one company. Unlike many long-standing corporations, its revenue streams continue to expand at an impressive rate.

Free Cash Flow Yield

Examining Microsoft’s valuation over time, the free cash flow yield—which measures how much free cash flow the company generates per $100 invested—has declined. In 2014-2016, Microsoft had a 6-7.7% free cash flow yield, but by 2024, it had dropped to 2.18%. This reflects the market’s willingness to pay a higher premium for Microsoft stock, but whether this valuation is justified depends on future free cash flow growth.

Financial Stability & Activision Blizzard Acquisition

Looking at Microsoft’s balance sheet:

• Debt-to-assets ratio: 0.212, with total assets of $533 billion and total debt at $62 billion—a healthy position.

• Interest coverage ratio: 29.74, indicating that Microsoft can easily cover its interest payments.

• Current ratio: While declining, this is largely due to the $68.7 billion all-cash acquisition of Activision Blizzard, which temporarily reduced total current assets.

Is Microsoft Overvalued?

At $392 per share, Microsoft has dropped 8-9% in the last month, but is it still too expensive? Looking at valuation models:

• Discounted Cash Flow (DCF) Analysis: Assuming 15% future free cash flow growth, the fair value comes out to $344 per share, suggesting it may be overvalued at current levels.

• Historical PE Ratio: The 10-year average PE is 28.8, but the current PE is 31.5, making it about 9% more expensive than historical norms.

Microsoft’s Valuation Compared to Peers

When analyzing Microsoft from a multiples valuation or comparables valuation, there isn't a perfect direct comparison. However, we can compare it to other major tech companies like Apple, Meta, and Amazon, which have an average price-to-earnings (P/E) ratio of 33.04. If we apply this same multiple to Microsoft, we arrive at an intrinsic value of approximately $425 per share.

Next, using the dividend discount model—which values the company based on its dividend payouts and expected growth—Microsoft’s historical dividend growth rate of 8.25% leads to an estimated intrinsic value of $456 per share, about 16% higher than the current price.

By averaging these three valuation models, we get an intrinsic value of $444 per share, which is roughly 2.84% above the current price. Applying a 10% margin of safety, the acceptable buy price would be $363 per share, while a 20% margin of safety would bring it down to $323.20 per share.

Should You Buy Microsoft Now?

It's rare to see Microsoft trade at a significant discount to its intrinsic value, and it typically commands a premium. I initially started buying shares in the low $200s during 2022 and have added periodically, including when it dipped below $400 in August 2024.

At current prices, Microsoft is becoming attractive again. If we were to see a broad market selloff or enter a bear market, I would be looking to increase my position significantly. It remains one of the highest-quality companies available, with valuation being the key factor to watch.

Conclusion

Microsoft remains a dominant force with strong growth across its business segments, a robust balance sheet, and a clear competitive advantage. However, valuation metrics suggest the stock is trading at a premium. Investors should consider whether its long-term potential justifies the current price or if they should wait for a more attractive entry point.

Despite short-term headwinds, Microsoft remains a fundamentally strong company with significant long-term potential, particularly with its advancements in quantum computing and AI. The current sell-off could present an opportunity for long-term investors to take advantage of market fear.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

@Daily_Discussion @TigerPM @TigerObserver @Tiger_comments @TigerClub